Short Sale Sellers Lose Tax Relief in 2015

Tax Relief for Short Sale Sellers expires on December 31, 2014 unless renewed by Congress.

Short Sale Sellers Lose Tax Relief in 2015

Did you know the IRS taxes debt forgiveness and debt cancellation the same way as any other income? If not for the Mortgage Forgiveness Debt Relief Act, sellers would be subject to income taxation on the amount of loan forgiveness or loan cancellation they receive in a short sale closing of their primary residence. Although Congress extended the Act for short sales occurring through 2014, unless it is renewed, the law is now expired for transactions that occur in 2015.

The defining characteristic of a short sale transaction is a real estate closing where the proceeds are insufficient to payoff outstanding mortgage loan balances. However, short sale transactions come in two flavors— one which results in income recognition and one which does not. If the borrower agrees to repay the full remaining loan balance after closing, this loan modification may not result in imputed income. On the other hand, the lender may agree to forgive, or cancel, any loan balance not covered by the sale proceeds, and this type of short sale would result in income recognition by the amount forgiven.

In the case of investment property short sales, imputed income from loan forgiveness may, in some situations, be offset by a capital loss. The Mortgage Relief Act is important because, unlike investment properties, a loss on the sale of a main home cannot be deducted. While amounts forgiven or cancelled by mortgage lenders would ordinarily be taxed as income, the Act exempts certain qualified transactions from income. For example, on qualified principal residence indebtedness (the key here is “principal residence”) taxpayers may exclude up to $2,000,000 or $1,000,000 if married filing separately. The rules require filing IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness and taking a basis reduction.

Tax laws are complex by nature and the future of the Mortgage Relief Act is unpredictable. The Act originally became law in 2007; however, Congress did not extend the law for 2014 short sales until the very end of December. The best advice for upside-down homeowners in 2015 is to discuss their particular situation with a trusted tax advisor or attorney before entering into a short sale transaction.